Price Action Patterns

Price action patterns are formations based on changes in an asset's price. They are part of technical analysis and can help traders assess:

• Possible future price movements
• Market direction

Price action patterns can be divided into two broad categories.

Candlestick patterns

Candlestick patterns are formations created by one or more candlesticks on a price chart.

Some common examples include:

• Bullish and bearish engulfing patterns
• Morning star candlestick pattern
• Doji candlestick pattern
• Hammer candles

Chart patterns

Chart patterns are formations created as prices move over time.

Some common examples include:

• Head and shoulders patterns
• Triangles
• Rectangles
• Flags and pennants

One of the main uses of price action patterns is to help traders identify market trends. These trends may be:

• Upward
• Downward
• Sideways

Price action patterns can also help traders assess possible entry and exit points and confirm signals from other technical tools.

For example, suppose you observe a bullish reversal pattern. You may consider it while assessing a possible long trade.

If you spot a bearish reversal pattern, you may instead consider exiting an existing position or initiating a short position.

Another example is a moving average crossover that suggests a possible trend reversal. You may look for further confirmation, such as a bullish engulfing pattern appearing near a support level.

Let us understand the practical use of a popular price action trading pattern, the Doji candlestick pattern, with a hypothetical example.

The scenario

Suppose you are analysing a daily candlestick chart and notice a Doji after a prolonged uptrend.

A Doji generally shows that:

• The opening and closing prices are very close.
• Neither buyers nor sellers gained clear control during the session.
• There is uncertainty or indecision in the market.

You may interpret the Doji as a warning of a possible change in the existing trend. However, the pattern alone does not confirm that the trend will reverse.

Adjusting positions

After noticing a possible change in the trend, you may consider adjusting your positions in different ways.

Reduce position size

You may reduce the size of your existing position to:

• Limit potential losses
• Lock in part of an existing profit

Partial profit taking

You may book part of the profit on an existing position while keeping some exposure to further market movements.

Initiate new positions

You may consider a new position if the expected change in the trend is supported by further price movement.

For example, when assessing a possible shift from a bullish to a bearish trend, you may consider:

• Initiating a short position
• Purchasing put options

Human psychology plays an important role in price action trading because traders interpret market movements and make decisions based on them.

Emotions such as greed, fear, and overconfidence can affect these decisions.

Strong trading psychology can help you analyse price action patterns more calmly and make more disciplined decisions.

Self-awareness

Understand your:

• Strengths
• Weaknesses
• Emotional triggers

Recognising how emotions affect your decisions can help you avoid acting impulsively.

Mindfulness

Practising mindfulness can help you stay present and focused while trading.

It may help you:

• Avoid impulsive decisions
• Maintain clarity while analysing the market

Acceptance of uncertainty

Trading involves uncertainty, and losses can occur.

You can develop resilience by learning from setbacks and reviewing mistakes instead of assuming that every trade will work as expected.

Risk management

Risk management practices can help protect your capital and limit potential losses.

These practices may include:

• Setting stop-loss orders
• Managing position sizes
• Diversifying your portfolio

Journaling

A trading journal can help you track:

• Trades
• Emotions
• Thoughts

You can record these details before, during, and after each trade. Reviewing your journal regularly may help you identify patterns, strengths, and areas for improvement.